Interest Rate Determination

Money Supply Measure "M1"

M1 consists of the most highly liquid assets. That is, M1 includes all forms of assets that are easily exchangeable as payment for goods and services. It consists of coin and currency in circulation, traveler's checks, demand deposits, and other checkable deposits.

The first item in M1 is currency and coin in circulation. In the United States, "currency" refers to $1, $5, $10, $20, $50, and $100 bills. U.S. "coin," meanwhile, refers to pennies, nickels, dimes, and quarters. "In circulation" means that it has to be outside of banks, in people's wallets or purses and businesses' cash registers. Once the currency or coin is deposited in a bank, it is no longer considered to be in circulation, thus it is no longer a part of the M1 money supply.

The second item of M1 is traveler's checks. Traveler's checks are like currency, except that they have a form of insurance tied to them. If a traveler's check is lost or stolen, the issuer will reimburse you for the loss.

The third item in M1 is demand deposits or checking account balances in banks. These consist of money individuals and businesses have deposited into an account in which a check can be written to pay for goods and services. When a check is presented to the bank, it represents a demand for transfer of funds from the check writer to the agent receiving the check. Since the funds must be disbursed on demand, we also refer to these as demand deposits.

The final category in M1 is labeled "other checkable deposits". This consists of two items; NOW accounts and ATS accounts. NOW stands for "negotiable orders of withdrawal". A NOW account is exactly like a checking account except for one thing: it can earn interest. Thus checking accounts without interest are demand deposits and those with interest are NOW accounts. ATS stands for "automatic transfer service". ATS accounts are savings accounts (also called time deposits) with one special feature. They can be drawn automatically to cover overdrafts from one's checking account. Thus if an individual has a checking account with "overdraft protection" tied to their savings account, then the savings account is an ATS account.

Table 18.1 "Components of U.S. M1 Money Supply, November 2009" shows the M1 money supply for the U.S. economy as of January 2005. Notice that the largest component of M1, just over half, is the coin and currency in circulation. Traveler's checks are an insignificant share at $7.5 billion. Demand deposits and other checkable deposits almost equally split the remaining shares of M1 at close to 25 percent each. The total value of the M1 money supply is $1,688 billion, which is over 10 percent of annual U.S. GDP.

Table 18.1 Components of U.S. M1 Money Supply, November 2009